Aave is the largest DeFi lending protocol with more than $16 billion in cryptocurrency assets locked. It’s planning to launch Aave Pro, which will operate segregated permissioned pools of ‘whitelisted’ users that have passed Know Your Customer (KYC) protocols. This removes one of the key roadblocks to regulated institutions participating in decentralized finance (DeFi).
Why would institutions be interested? Because they can earn 2.1% (3.2% including Aave token rewards) on U.S. dollars with relatively low risk, though it’s not riskless. The returns are possible because cryptocurrency investors don’t want to sell their Bitcoin. Using a smart contract based protocol, they borrow up to 85% of the value of their holdings and pay 3.1% for the secured loan. For depositors, competitor Compound offers a lower return of 1.6% for lower risk because a maximum of 70% is loaned against the secured cryptocurrency. If the cryptocurrency price drops too low, the asset used as security is automatically liquidated.
The recent steep decline in prices was a good test for the sector. While it has come through well, it is still not riskless. There is the possibility that if a cryptocurrency price decline is sufficiently steep that the asset used as security might not be capable of being sold fast enough. Or some smart contract bug could be uncovered. For the main protocol, by now the bugs should have been ironed out because there has been a lot of money locked for some time.
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